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Voluntary Equity, Project Risk, and Capital Requirements

Author

Listed:
  • Haufler, Andreas

    (LMU Munich)

  • Lülfesmann, Christoph

    (Simon Fraser University)

Abstract
We introduce a model of the banking sector that formally incorporates a buffer function of capital. Heterogeneous banks choose their portfolio risk, bank size, and capital holdings. Banks voluntarily hold equity when the buffer effect against the risk of default outweighs the cost advantages of debt financing. In this setting, banks with lower monitoring costs are larger, choose riskier portfolios, and have less equity. Moreover, binding capital requirements or levies on bank borrowing are shown to make higher-risk portfolios more attractive. Accounting for banks' interior capital choices can thus explain why higher capital ratios incentivize banks to undertake riskier projects.

Suggested Citation

  • Haufler, Andreas & Lülfesmann, Christoph, 2022. "Voluntary Equity, Project Risk, and Capital Requirements," Rationality and Competition Discussion Paper Series 357, CRC TRR 190 Rationality and Competition.
    • Handle: RePEc:rco:dpaper:357
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    References listed on IDEAS

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    More about this item

    Keywords

    voluntary equity; capital requirements; bank heterogeneity;
    All these keywords.

    JEL classification:

    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation
    • H32 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Firm

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